Integrating Impact Funds into Mainstream Portfolios

Abstract

Interest in impact investing is growing, but investors typically allocate to impact funds and traditional assets independently from one another. We develop an optimizer that brings both types of assets together. Doing so allows investors to maximize impact for a certain level of risk-adjusted returns. For example, we find that investors can allocate 18% more to impact funds on average while keeping risk-adjusted returns constant. Intuitively, analyzing how impact funds and traditional assets interact should allow for better portfolio diversification. As interest in impact investing broadens, tools integrating impact funds into mainstream finance should become more widespread. <b>TOPICS:</b>ESG investing, portfolio construction, performance measurement, wealth management <b>Key Findings</b> ▪ We design a portfolio optimizer that brings together impact investments and traditional assets. Our optimizer has three dimensions: risk, return, and impact. Intuitively, returns from impact funds correlate with traditional asset returns. Taking such correlations into account allows for better portfolio diversification. That is, investors can achieve higher impact without hurting risk-adjusted returns. ▪ Diversification benefits can be large. Our optimizer allows an investor to increase impact by 18% without financial sacrifice. ▪ Demand for impact investing is rising. Tools that help to integrate impact funds into traditional portfolios are therefore useful and likely will become more widespread.